Magazine article The CPA Journal

Considering Roth IRA Conversions

Magazine article The CPA Journal

Considering Roth IRA Conversions

Article excerpt

Is Recharacterization a Viable Option for Taxpayers?

In light of continued volatility in the markets and the recent expansion of the scope of Roth individual retirement account (IRA) conversions under the American Taxpayer Relief Act of 2012 (ATRA), some taxpayers might be reconsidering the decision to complete a Roth conversion during 2013 and pay taxes owed. In order to best advise these taxpayers, tax professionals should remain aware of both the costs and benefits of converting to a Roth account, as well as the possibilities and limitations of reconsidering, or "recharacterizing," Roth conversions. Recharacterization might represent a practical option for taxpayers reconsidering a prior Roth IRA conversion, especially those who are adversely impacted by market conditions that have materially decreased the value of the converted account.

Roth IRAs Versus Traditional IRAs

Roth IRAs were established in 1997 as an alternative tax-deferred investment vehicle to traditional IRAs and pension plans. In contrast to the back-loaded tax liability of such traditional investment options, Roth IRAs have a front-loaded tax liability-that is, instead of contributing pretax dollars to a fund where growth is tax free and distributions are fully taxed, Roth IRAs involve contributions of earned income net of tax with tax-free growth and tax-free distributions.

Many estate and financial planners favor Roth IRAs over traditional IRAs for numerous reasons, including the following:

* Assuming even a modest amount of investment growth, the overall tax liability is appreciably lower.

* Traditional IRAs are subject to required minimum distributions (RMD) in the year that the taxpayer reaches age 70M, whereas Roth IRAs are not.

* Roth and traditional IRAs are generally valued equally for estate tax purposes, despite the fact that traditional IRA distributions are treated as taxable income to recipients, whereas Roth IRA distributions are tax free.

Although Roth and traditional IRAs are subject to the same annual contribution limitations ($5,500 for single taxpayers in 2013 or $6,500 for taxpayers who are older than age 50 in 2013), Roth IRAs are restricted to annual earned income levels of $112,000 (phasing out at $127,000) for single taxpayers and $178,000 (phasing out at $188,000) for married taxpayers filing jointly.

In 2006, the "Roth concept" was expanded to employee elective deferrals under 401(k) cash or deferred arrangements (CODA)-that is, "an arrangement under which an eligible employee may make cash or deferred election with respect to accruals or other benefits," according to the 1RS ( Where such 401 (k) plans have been amended to allow for elective Roth contributions, the annual deferral limitations are much higher-$17,500 (or $23,000 for those age 50 or older).

Expanding the Scope of Roth IRAs

In 2010, the Hiring Incentives to Restore Employment (HIRE) Act materially expanded the scope of Roth IRA deferrals; this allowed conversion from traditional IRAs and certain pension plans to Roth IRAs without limitations on income level or filing status. Furthermore, taxable income created by a conversion in 2010 could be recognized across a delayed two-year period (2011-2012); thus, conversions were taxable largely in the year following a rollover (with the return).

Conversions from traditional IRAs, simplified employee pension (SEP) plans, or Savings Incentive Match Plan for Employees (Simple) IRAs (if held for at least two years) can be achieved through one of the following three methods: 1) a distribution from a traditional IRA that is rolled over into a Roth account within 60 days of distribution; 2) a trustee-to-trustee transfer from a traditional to Roth IRA; or 3) a transfer of accounts (traditional to Roth), where the same trustee maintains both accounts. In addition, 401(k) plan distributions-such as in the year of termination, retirement, or upon reaching age 59[A-can also be converted. …

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